Card Networks’ Reach, Debit Programs Will Help Dictate Their Profitability: Report

Company profits in the payment card industry generally are on track to increase in 2011 if credit and debit card purchase volume continues its post-recession growth. But the fortunes of the four largest card networks may vary significantly in 2011, a new report suggests.

Visa Inc., MasterCard Worldwide, American Express Co. and Discover Financial Services share certain basic economic opportunities and risks as the economy stabilizes and mobile payments begin to take shape in the U.S., analysts Sanjay Sakhrani and Steven Kwok of New York-based Keefe, Bruyette & Woods note in their Dec. 20 report. But key differences among the networks likely will dictate their performance in the upcoming year more so than in previous years, the analysts contend.

Differentiating factors include the increasingly unique international and demographic reach each card network has and their respective debit card market share, the analysts suggest. The upcoming year also could prove the wisdom or folly of various recently formed partnerships, acquisitions and other strategies designed to capitalize on market opportunities, including emerging and mobile payments, they say.

 Each network’s skill in navigating tricky political waters also is likely to come into play, the analysts suggest in the 56-page report.

Not surprisingly, the analysts expect Visa in 2011 to continue to enjoy an advantage over rivals from its dominant U.S. market share in credit and debit and its “strong” relationships with banks.

But Visa is likely to be more “negatively impacted” by the Federal Reserve Board’s proposed new rules than is MasterCard because of MasterCard’s relatively low U.S. debit card market share. The proposed rules will restrict debit card interchange revenue and require banks to offer merchants a choice in which debit card network to route transactions (see story).

MasterCard as a result “could actually gain market share in debit,” the analysts write.

Moreover, MasterCard recently began to put fresh pressure on its chief rival. It “battled back and picked off some wins” versus Visa in signing new signature-debit contracts with banks, which bodes in its favor for competing with Visa in 2011, the analysts say. SunTrust Banks Inc., Chevy Chase Bank and Sovereign Bank in 2010 all converted their debit card portfolios to MasterCard from Visa (see story). 

 MasterCard also derives more than half of its revenues from outside the U.S., a goal Visa announced this year but has not yet officially attained. MasterCard’s operations include Europe, which was a strength before the recession but “as troubles have mounted for the European region as a whole, it’s been a headwind to top- and bottom-line growth,” the analysts note.

The Single Euro Payments Area initiative was viewed as a “big opportunity” for MasterCard, given the strength of its Maestro debit card brand in Europe, but the analysts say the company’s growth related to SEPA was “more modest than originally anticipated” because economic turmoil and complications in getting institutions to comply.

Europe remains in the grip of a global recession, but “we believe having this global positioning is a strength longer term” for MasterCard versus Visa, according to the analysts. Visa Inc.’s operations do not include Visa Europe, which the company spun off before its 2008 initial public offering.

As for Visa and MasterCard’s core bankcard issuers, credit card purchase volume next year “could be stronger than expected given our view that issuers are likely to encourage consumers to increase their credit card usage post-implementation of the Durbin Amendment, when debit card interchange fees are subject to oversight by the Federal Reserve,” the analysts write. The Fed on Dec. 16 announced proposed new rules for debit interchange, as a result of legislation passed earlier this year (see story). 

AmEx, with its strong focus on affluent consumers, a segment whose purchase volume held up fairly well through the recession, is positioned to continue reaping relatively strong sales as the recession’s effects abate, the analysts predict. But AmEx simultaneously faces stiff legal challenges, including a U.S. Department of Justice lawsuit (see story) and concern among investors that legislators or regulators seeking to reduce merchant fees could target AmEx’s higher-than-average merchant discount rate.

Keefe, Bruyette & Woods believes “odds are high” that AmEx will prevail in the DOJ case, which the firm deems “a battle that is worth fighting” given its relatively lower market share compared with Visa and MasterCard.

AmEx likely would bounce back from any potential credit card interchange regulation, which has not surfaced but some observers believe eventually could follow the Fed’s proposed debit card interchange reductions. In “the most onerous (future credit card interchange regulation) scenario,” Keefe, Bruyette & Woods speculates that AmEx could be forced to reduce its discount rate by 20 to 30 basis points to equal that of Visa and MasterCard.

Even if that scenario were to play out, the analysts view the potential revenue hit as “manageable” and predicts that the company likely could offset potential interchange revenue losses by making certain adjustments in managing its expenses and capital.

Moreover, credit card interchange regulation is less likely to dominate the stage next year “given the Republican’s more-prominent position in Congress as well as some respect for the fact that there are higher costs associated with credit cards,” the analysts write.

AmEx’s recent strategic moves in the emerging- and mobile-payments space also bode well for the company, the analysts say. AmEx’s 2009 acquisition of Revolution Money “enhanced” its competitive position in alternative payments, and its creation this year of a Global Services group and an Enterprise Growth group to explore new payments technology remains a positive, according to the analysts.

Discover also is in a stronger position this year than it has been recently, the analysts say. On the issuing side, Discover has a “simpler” balance sheet than some of its competitors, with credit card receivables comprising some 86% of its total loan portfolio. Discover weathered the recession with relatively lower charge-offs.

Keefe, Bruyette & Woods also applauds Discover’s diversification this year into student loans, most of which were acquired from Citigroup Inc. and “are 70% insured by the bank for losses.”

Discover also grabbed attention this year by forming a partnership with AT&T, T-Mobile and Verizon Wireless for Isis, a national mobile payment and commerce network announced in November with Discover acting as the exclusive payments network (see story).

Although details about the business model remain hazy, the Isis announcement has “opened the flood gates for mobile-payments movement,” the analysts contend.

But Discover also remains at risk to be acquired by another network or large bank, the analysts contend. The network’s increasingly broad third-party credit and debit card acceptance network, with dozens of new global card-acceptance agreements signed within the last year, has strengthened its value as a transaction-processing network (see story).

Discover’s card-acceptance network could be worth as much as $2 billion to an acquirer, Keefe, Bruyette & Woods estimates, suggesting its card portfolio also could be attractive as a separate asset.

 “Card receivables will be one of the most profitable asset classes within a bank’s portfolio and, therefore, should be sought after when capital levels rebound for larger banks,” the analysts note regarding Discover’s potential acquisition value to another bank.

Still unclear to the analysts is whether credit card receivables as a whole will begin to increase again next year as some firms have speculated (see story).

“Receivables growth is an interesting topic, as it is unclear whether or not we could actually see growth in 2011,” the analysts write. “Longer term, outside of a renewed appetite for leverage from consumers or a significant pick up in the economy, we believe credit card receivables should also benefit from the contraction in the availability of home equity loans, ... which (prior to the recession) were taking market share from credit cards on consumers’ balance sheets,” the firm notes in the report.

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